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71) Ideally, a company reaches a point where increases in operating efficiency mean that
expenses as a percentage of sales revenue flatten or even decline. This is referred to as
________.
A) net profit to assets ratio
B) profitability ratio
C) net profit to equity
D) operating leverage
72) The ________ ratio measures the owner's rate of return on the investment in the business.
A) net profit to equity
B) net profit on sales
C) quick profit
D) net sales to working capital
73) The net profit to asset ratio measures ________.
A) the owner's rate of return on investment
B) how much profit a company generates for each dollar of assets that it owns
C) a company's profit per dollar of sales
D) a company's ability to generate sales in relation to its asset base
For Meters, Inc., refer to the following information to answer the question(s) below:
Meters, Inc., reported net sales of $874,916 and a net profit of $74,563 on its most recent income
statement. The company's balance sheet shows total assets of $342,742 and total liabilities of
$88,367.
74) What is the net profit margin for Meters, Inc.?
A) 8.5 percent
B) 1.91:1
C) 21.8 percent
D) 29.3 percent
75) What is the return on net worth ratio for Meters, Inc.?
A) 8.5 percent
B) 1.91:1
C) 21.8 percent
D) 29.3 percent
76) Ratio analysis allows a business owner to identify potential problem areas in her/his business
before they become business-threatening crises.
77) Ratio analysis is a useful managerial tool that can help business owners maintain financial
control over their businesses, but it is of no use to a business owner trying to obtain a bank loan.
78) Liquidity ratios (such as the current and the quick ratios) tell whether a small business will
be able to meet its short-term obligations as they come due.
79) Liquidity ratios help a business owner evaluate a small company's performance and indicate
how effectively it employs its resources.
80) A current ratio of 2.4:1 means that a small company has $2.40 in current liabilities for every
$1 in current assets.
81) A high current ratio guarantees that the small firm's assets are being used in the most
profitable manner.
82) Generally, the higher the current ratio, the stronger the small firm's financial position.
83) Most firms calculate their quick assets by subtracting the value of their inventory from their
current asset total.
84) A quick ratio of more than 1:1 suggests that a small company is overly dependent on
inventory and future sales to satisfy its short-term debt.
85) Leverage ratios measure the financing supplied by the firm's owner against that supplied by
his creditors.
86) Small businesses with high leverage ratios are more vulnerable to economic downturns, but
they have greater potential for large profits.
87) Taking on debt destroys a business; therefore, small business owners should avoid it at all
costs.
88) The small business with a high debt-to-net worth ratio has more borrowing capacity than a
firm with a low ratio.
89) As a company's debt-to-net worth ratio approaches 1:1, its creditors' interest in that business
approaches that of the owners.
90) A company with a low debt-to-net worth ratio has less capacity to borrow than a company
with a high debt-to-net worth ratio.
91) The times-interest-earned ratio tells how many times the company's earnings cover the
interest payments on the debt it is carrying.
92) Operating ratios measure the extent to which an entrepreneur relies on debt capital rather
than equity capital to finance the business.
93) The average inventory turnover ratio measures the number of times a company's inventory is
sold out during the accounting period.
94) An inventory turnover ratio above the industry average suggests that a business is
overstocked with obsolete, stale, overpriced, or unpopular merchandise.
95) A high inventory turnover ratio relative to the industry average could mean that a business
has too little inventory and is experiencing stockouts.
96) A company's average collection period ratio tells the average number of days it takes to
collect its accounts receivable.
97) The net-sales-to-total assets ratio is also referred to as the total asset turnover.
98) The net-sales-to-total assets ratio measures a company's ability to generate sales in relation to
its asset base.
99) Float is the net number of days of cash flowing into or out of a company.
100) The net profit on sales ratio measures the owner's rate of return on the investment in the
business.
101) The net profit to equity ratio reports the percentage of the owners' investment in the
business that is being returned through profits annually.
102) Explain what ratio analysis is. Name the four categories of ratios and describe the type of
information each group provides the small business owner.
103) List the 12 key ratios outlined in the text and explain the type of information they provide
the small business owner.
Mini-Case 12-5: A Projected Income Statement
You want to start your own retail furniture store, and you have already gathered a great deal of
information on location, layout, form of ownership, business failure rates, etc. In applying for a
loan, you notice that a projected income statement is required. Your problem is to complete this
projected "P&L," given a desired income of $23,000 and the following published statistics. Show
and clearly label all of your work!
Cost of Goods Sold 60.3 percent of net sales
Operating Expenses 36.4 percent of net sales
Gross Profit Margin 39.7 percent of net sales
104) If a market survey indicates that your firm's sales would be $620,000, what net profit would
you expect to earn?
30
Mini-Case 12-2: Bowden Brake Service (Part B)
One day while you are in Bowden Brake Service getting your brakes repaired, Jim storms into
his office, slamming doors and shouting about the local financial institutions. After a few
minutes of building your courage, you approach Jim and ask him what the problem is. He shouts,
"It's the financial institutions in this town! Not one of them will lend me the money I need to
expand my business. They all said I needed to take a closer look at my financial position before I
consider expanding. One of them said something about ratio analysis. I know a lot about cars and
brakes, but what is ratio analysis?"
You tell Jim you will perform a ratio analysis for the business if he gives you a free brake job.
Jim provides you with the following financial statements.
Bowden Brake Service
Income Statement
Year Ending December 31, 2007
Net Sales $780,000
Costs of Goods Sold:
Beginning Inventory $104,000
Purchases 526,480
Goods Available for Sale $630,480
Ending Inventory 134,400
Costs of Goods Sold 496,080
Gross Margin $283,920
Operating Expenses:
Rent 24,000
Insurance 5,250
Advertising 6,000
Travel 2,500
Interest 72,750
Taxes (Property, etc.) 2,500
Salaries & Admin. Expenses 97,000
Utilities 12,500
Supplies 1,360
Total Operating Expenses $223,860
Net Profit $60,060
31
Bowden Brake Service
Balance Sheet
December 31, 2007
Assets
Current Assets:
Cash $20,000
Accounts Receivable 10,000
Notes Receivable 5,000
Inventory 134,400
Total Current Assets $169,400
Fixed Assets:
Land 147,000
Machinery 73,000
Equipment 160,800
Less Accumulated Depreciation (30,200) 203,600
Total Fixed Assets 350,600
Total Assets $520,000
Liabilities & Owner's Equity
Current Liabilities:
Accounts Payable 40,500
Notes Payable 20,200
Accrued Salaries Payable 4,300
Total Current Liabilities: 65,000
Long-term Liabilities: Long-term Loan 325,000
Total Liabilities $390,000
Owner's Equity, Jim Bowden $130,000
Total Liabilities and Net Worth $520,000
105) Refer to the income statement and balance sheet. Prepare a ratio analysis for Bowden Brake
Service. In addition, use the following industry statistics for firms like Jim's to explain and
interpret what these ratios mean.
106) You are provided this information about a retail store called "BoardSports:"
BoardSports Industry Mean
Current Ratio 1.5 : 1 2: 1
Quick Ratio .75 : 1 1 : 1
Debt Ratio 0.87 : 1 0.75 : 1
Average Collection Ratio 46 days 33 days
Net Profit on Sales Ratio 5.5% 8.2%
Net Profit to Equity Ratio 7.7% 13.2%
What can you reasonably assess about the current financial status of this company?
A) The company is in excellent financial condition with no changes required.
B) The company is in respectable financial condition with no changes required.
C) The company is in questionable financial condition with minor changes required.
D) The company is in poor financial condition with significant changes required.
107) A company with a times-interest-earned ratio that is well above the industry average would
likely have difficulty making the interest payments on its loans, as creditors would see that it was
overextended in its debts.
108) Creditors often look for a times-interest-earned ratio of at least 4:1 to 6:1 before
pronouncing a company a good credit risk.
109) Generally, the higher the small firm's average collection period ratio, the greater the chance
of bad debt losses.
110) Slow accounts receivable are a real danger to a small business because they often lead to
cash crises.
111) If a company's average payable period ratio is significantly lower than the credit terms
vendors offer, it may be a sign that the company is not using its cash most effectively.
112) An excessively high average payable period ratio indicates the possibility of the presence of
a significant amount of past-due accounts payable.
113) Although sound cash management principles call for a business owner to keep her/his cash
as long as possible, slowing accounts payable too drastically can severely damage a company's
credit rating.
114) Ratio analysis provides an owner with a "snapshot" of the company's financial picture at a
single instant; therefore, (s)he should track these ratios over time, looking for trends that
otherwise might go undetected.
